Mortgage Customer Protection Plan.TM. (MCPP) is a life insurance plan that allows financial organizations, such as banks ("lenders"), to provide free mortgage insurance to its customers ("borrowers"). Using MCPP.TM., the lender takes out insurance on the borrower(s) seeking the mortgage. Often, the mortgage will be applied for jointly (e.g., married couples) or with a co-signor. The lender pays the life insurance premiums and is the beneficiary. In the case of death of one of the borrowers, the lender can use the death benefits from the insurance policy to offset the remaining mortgage balance for the surviving borrower(s). Using MCPP.TM., the lender can provide this benefit without any direct cost to the borrower. The lender can fund MCPP entirely by the revenues gained from the cash build-up of the insurance policies and the tax-benefits associated with such policies.
A number of life insurance plans are available to lenders to increase lender revenues, thus increasing the number and quality of lender services and decreasing the need to profit from the average customer. These plans, however, are complicated, subject to strict federal regulations, and offer little or no benefit to the borrowers or public at large. Further, none of these plans relate to insuring customer mortgages.
One such plan is known as Corporate-Owned Life Insurance (COLI). COLI plans generally work as follows: a company buys life insurance on workers and retirees naming the corporation as beneficiary; the cash value of the policy then builds as an asset. Since COLI is life insurance, the interest on amounts borrowed from the life insurance plan are tax-deductible. In addition, the actual build-up of cash in the life insurance policy also is not taxable. Upon the death of the insured, the death benefits are not taxable as well.
Despite these advantages, COLI has many drawbacks. Congress recently placed limits on the amount of interest that can be deducted from borrowing from the plan. Moreover, pending federal legislation if enacted may prevent lenders from deducting any interest on policy loans from the plan. In addition, only the cash value of the policy with the loans deducted are allowed to be reported on the balance sheets for accounting purposes, which can often affect corporate net worth.
Another life insurance plan available to lenders is Bank-Owned Life Insurance (BOLI). BOLI is often used to fund health care liabilities for lender employees. Under a BOLI plan, a lender purchases insurance on a group of employees. The group can be all full time employees or a group of managers, e.g., assistant vice presidents and above. The lender pays the premium(s) and owns the cash value of the polices. The lender is also the beneficiary of the insurance. The employees may or may not receive any of the insurance benefits directly depending upon the discretion of the financial organization. The coverage does not replace or interfere with any other insurance provided by the lender, e.g., group term life insurance and so forth.
The lender earns income from the policies from two sources. The first is from the growth of the cash value of the policy. The cash value is the monetary value of the policy if surrendered. It is also the value which is counted as an asset by the lender. The cash value increases each year as interest is added by the insurance company. The second source of income comes from the insurance proceeds paid to the lender when an employee dies. The payment of insurance proceeds and the earnings from the cash value are income tax-free (unless surrendered).
Similar to COLI, the traditional BOLI plan has inherent drawbacks which makes it unattractive to the banking industry. In particular, lenders are not comfortable making a large premium payment to a carrier that would go into the general account or portfolio of the carrier. If the carrier has a credit difficulty or an impediment to making payments, the lender becomes the general creditor of the carrier. Thus there is a problem with maintaining control over the lenders' transferred assets. Further, given the long-term nature of the plan, lenders were concerned with the long-term credit worthiness of the insurance carriers and the delay in cash flow (since it is predicated on the death of an employee). Another problem with traditional BOLI products is that lenders can only lend 15% of shareholder equity to a single entity, and only 25% total of a lender's shareholder equity can be used for life insurance. Thus, if a favored carrier of the lender has existing insurance products, the premium amount the lender could pay to the carrier would be limited. Finally, the plan fails to provide an after-tax interest gain exceeding straightforward and vastly less complicated investments such as Treasury Bills.
In addition to the above mentioned problems with traditional life insurance plans, COLI and BOLI are both subject to strict governmental regulations. Both plans must adhere to the insurable interest laws of the applicable State. Moreover, both plans are regulated through federal guidelines established by the Office of the Comptroller of the Currency (the "OCC"), and OCC Banking Circular 249 (the "Circular").
The OCC provides federal regulatory oversight for a national lender's purchase of life insurance policies. The Circular provides general guidelines for national lenders to use in determining whether they may purchase a particular life insurance product. Under the Circular, a national lender may purchase life insurance only for a purpose incidental to the business of banking, and not as an investment. A life insurance policy is considered to be purchased and held for non-investment purposes if it satisfies either of two tests. Test A applies if a lender purchases life insurance to indemnify itself against the death of an individual, i.e., key-person insurance. Test B applies when the lender purchases life insurance in conjunction with providing certain employee compensation or benefits, or when the insurance constitutes all or part of the benefit. Both tests involve complicated and strict compliance rules. For example, based upon reasonable actuarial benefit and financial assumptions, test B requires that the present value of the projected cash flow from the policy must not substantially exceed the present value of the projected cost of the associated compensation or benefit program liabilities. Accordingly, lenders are required to operate within strict parameters and are subject to heavy regulatory oversight.
Finally, both COLI and BOLI provide only indirect benefits to the bank employees which are insured by these plans by reducing a bank's health benefits costs, thereby providing better health benefits to the employees at reduced rates. These plans do not offer any direct benefits to the insured, or the public at large.
MCPP.TM. offers the same benefits as COLI and BOLI without the above-mentioned drawbacks. MCPP.TM. is an insurance policy on borrowers for which the lender pays the premiums and is the beneficiary. All or part of the proceeds, in the event of a death of a borrower with an outstanding mortgage, will be used to offset all or part of the mortgage balance. This benefit is provided without any direct cost to the borrower, in order to create business advantages through increased mortgage activity and persistency. The death benefits from the policies are not taxable income to the lender, therefore the cash value growth of the insurance is tax deferred. Accordingly, MCPP has favorable tax consequences when used as an investment.
Corporate owned life insurance (COLI) is often used for financing corporate benefit liabilities. The rate of return of a COLI investment is increased if the employer borrows against the cash value of the insurance policy. This allows the employer access to a significant portion of the value of the policy before the death of the insured employee. If a large portion of the cash value of the policy is borrowed and used to pay the premiums and/or interest on outstanding loans, substantial returns on investment can be achieved with minimal cash outlays. A similar result can be achieved with MCPP, in addition to the significant business advantages that MCPP provides.
More importantly, MCPP is not subject to federal oversight. The Circular permits a lender to insure mortgage borrowers, but is silent with respect to any regulatory requirements such as limits on policy coverage amounts or premium payments.
Additional advantages of MCPP to a lender is a relatively low rate plan on the insurance, increased market share through the offering of free or low-cost mortgage insurance, elimination of current credit losses, increased per capita advertising efficiency since the conversion rate for buyers is higher (e.g., for every 100 mortgage applications, a higher number of applicants will choose to borrow money from a lender offering free or low-cost mortgage insurance), and leverage to promote those mortgage products and terms which are most profitable to the lender (e.g., balloon mortgages versus fixed-rate mortgages).
The problems associated with implementing and administering a MCPP plan according to the needs of a particular financial organization are considerable. For example, there are problems associated with determining the insurable interest for each policy. Insurable interest is the amount of death benefits the financial organization could take out for each borrower. Insurable interest differs from state to state, and involves significant calculations factoring in such variables as mortgage amount, premium costs and interest on the premium costs. Moreover, even a small lender could easily provide mortgages for 50,000 borrowers. To calculate the insurable interest for each borrower would be nearly impossible without a readily implementable computer program that accounts for the state to state differences.
Yet another problem is the size and sheer volume of administrative functions associated with the ongoing management of the MCPP plan. These administrative functions include paying premiums for large numbers of borrowers ("mortgage pools"), and determining the premiums required for maintaining death benefits equal to the insurable interest on a periodic basis for accounting and tax purposes. Developing a programmatic approach to these administrative functions is critical to the ability to effectuate MCPP efficiently, economically and accurately.
Another problem revolves around the tax benefits provided by MCPP. Under current tax laws, the interest paid on policy loans, for a leveraged MCPP arrangement, is tax deductible. In the event that the tax laws change such that interest paid on policy loans are no longer tax deductible, however, a MCPP policy efficiently, economically and accurately with outstanding policy loans becomes a net loss investment. Therefore, companies are hesitant to use MCPP policies with borrowing of cash value due to the possibility of a tax law change. One known method for reducing losses from a MCPP if the tax laws change is to convert the outstanding cash value in the policy to a paid up insurance policy of a lesser face value. The interest on the loans, however, must still be paid as long as the policy is in force. A program and method is needed to reduce such losses without causing an administrative and accounting nightmare.
MCPP offers lenders and the public significant benefits. The MCPP plan, however, is new and only recently introduced to the insurance and banking industry. Consequently, no attention has been paid to developing computer software and computer hardware systems for handling the above-enumerated problems associated with the MCPP plan in order to minimize actuarial, management and accounting time and costs and to render such a plan feasible for large numbers of mortgages.